“Jack did more for American investors as a whole than any individual I’ve known. A lot of Wall Street is devoted to charging a lot for nothing. He charged nothing to accomplish a huge amount.” Warren Buffett to CNBC’s Becky Quick on the passing of Vanguard’s founder and former CEO, John C. “Jack” Bogle. Mr. Bogle passed away on Wednesday, January 16, 2018 at the age of 89.
We lost a GIANT in the financial industry yesterday. The very first book Allan gave me to read prior to my start at American Investment Advisors was Common Sense on Mutual Funds by John Bogle. In the years since, whenever he had an interview on CNBC, I would quickly stop whatever I was working on to listen to his words of wisdom. He consistently preached that low-cost index funds were the way to go, but only if you purchased them and held them for the long-term. He was a calming influence during bouts of market turmoil. All you have to do is look at your portfolio today to see what kind of influence he has had on our management. We have a substantial weighting in the total stock market index and many of our managed funds are run by the Vanguard Group. In my copy of one of his latest books on investing I mailed to him in March of 2017, The Little Book of Common Sense Investing, Mr. Bogle wrote “To William A. Bullock: With thanks for your support. “Stay the course!” Best, John C. Bogle.” Stay the course, indeed. While I will certainly miss hearing his take on today’s markets, his words of wisdom will live on for a very long time.
After an exuberant January followed by a couple of extremely volatile early days in February, the 2018 stock market made some peace and reached some nice new highs at the end of September. As we proceeded with the fourth quarter, the trade war with China started to heat up and the Fed continued with its fourth quarter-point increase of the year on December 19th. Investors were spooked that the Fed’s interest rate increases were on auto-pilot and were not well thought out. This led to the worst Christmas Eve market drop – ever. On that night the S&P 500 came within 23 basis points or 0.23% of becoming an official bear market, which is defined as a drop of 20% or more from a recent stock market high. Fortunately, as of this writing, Christmas Eve seems to be the market low – it has rallied ever since.
For those of you with taxable accounts, that volatility has presented us with an opportunity to lower your 2018 tax bill. Essentially, we sold the securities that had losses and purchased similar Schwab exchange traded funds (ETFs) that will, in turn, be sold 30+ days later so that we avoid the IRS wash sales rule. Purchasing the ETFs will allow us to take advantage of any up-turn in the market over those 30 days. If you were wondering why you received so many trade confirmations from Schwab at the end of the year - that was the reason. You should expect more trade confirmations to appear in February as we re-purchase the original securities that were sold in December.
Over the last few years, I have used this letter to have a slightly more detailed review of some of our areas of investment. Depending upon the size of your portfolio, most of you will own all of the securities mentioned below.
Fixed Income: As interest rates rise, the basket of bonds we are holding become slightly less valuable and prices for those bonds decline. In a nutshell, that is what happened in the fixed income arena this year. It didn’t matter if you owned short or intermediate-term bonds, both were breakeven for the year. That said, we can never discount the security bonds bring to our portfolios over the long-haul. In most cases, when investors sell stocks, they like to flee to safety and bonds are considered safer than equities.
Do you remember when Bill Gross left the management of PIMCO Total Return and that fund fell from the ranks of the largest bond fund in the world due to underperformance before and after Gross’ departure? Well, PIMCO must be feeling a bit more confident as of late. They continue to raise their funds’ expense ratios while other fund families are constantly looking to lower theirs. While funds like PIMCO Income and PIMCO Short-term have outperformed their respective benchmarks in the past - regardless of the expense ratio - I am quite concerned about these increases and will monitor this situation going forward.
Large-Cap Domestic Equities: For those of you who own Vanguard Dividend Growth in 2018, you saw a slightly positive 0.18% return while Berkshire Hathaway saw a rock solid 3.01% return in 2018. The rest of the funds like Schwab Total Stock Market, Schwab S&P 500, the Primecap funds and the Schwab U.S. Dividend Equity ETF all fell between 4 and 6%. I don’t plan on any changes in this category in 2019. Given the stock market volatility, these funds performed as advertised in 2018.
Mid and Small-Cap Equities: I finally lost my patience with Royce Special Equity and Royce Total Return. I sold Royce Special Equity earlier in the year while Royce Total Return was sold near the end of 2018. Both have been in the ballpark of their benchmark, the Russell 2000 index, over the years, but I have decided to go with the cheaper Vanguard Tax-Managed Small Cap fund for most of you. This fund follows the S&P Small-Cap 600 index, but in a tax-managed way. Thus, it has very few distributions which makes it an ideal candidate for taxable accounts. The long-term performance and low fees make it a great investment for any account: taxable, tax-deferred or tax-free.
Our mid-cap pick, Vanguard Selected Value (VASVX) had an extremely disappointing year. Some of you are in the Schwab U.S. Mid-Cap ETF (SCHM) in place of VASVX. I have always felt that using an inexpensive value management approach like VASVX would hold up better during corrections, but I was proven wrong over the past couple of months. Don’t be surprised if I continue to hold SCHM in those accounts where tax loss harvesting took place.
Foreign Equities: Foreign equities certainly owe us after trailing the U.S. over the past several years. I decided to eliminate IVA International in most portfolios in 2018. While I still like IVA’s management team, the Vanguard Global Wellington (VGWAX) team will be less expensive and just as good over a long-term time horizon. Moreover, the performance of VGWAX’s sister fund, Vanguard Wellington, has been second to none over the last decade or two. Thus, for the main portion of our overseas investing, I am falling back on our old reliable First Eagle Overseas and an extremely volatile Oakmark International fund. First Eagle should hold up better in foreign stock market downturns while Oakmark should provide some extra fuel when overseas markets do well. Both are deep-value funds, which I feel more comfortable with when we are trying to avoid the pitfalls inherent to international investing.
While I am disappointed with our 2018 returns, we need to remember that years like we just experienced are not out of the ordinary. We should expect them from time-to-time. These downturns are great for those contributing to retirement accounts on a regular basis, but not so good for those depending upon the market for their retirement income. While we cannot control the performance, we can control our allocation of stocks to bonds.